Understanding savings: start here!

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Saving can feel complicated when you're faced with unfamiliar terms, percentages, and product names.

This guide, written by our in-house Plain Numbers Practitioner, Rosie Edwards, explains some of the most common savings’ terms in everyday language so you can feel confident in deciding what's best for you.

Why understanding savings matters

Many of us save for many different reasons: unexpected expenses, holidays, Christmas, a new car, home improvements, or even peace of mind. 

Unfortunately, understanding how savings accounts work can be difficult when financial terms aren't explained clearly. The good news is that most savings products are much simpler than they first appear.

Seven savings terms worth knowing

Interest is the money a bank or building society pays you for keeping your money with them.

In practice:

If you save £1,000 and earn £40 in interest over a year, you'll have £1,040.

Why it matters:

Interest helps your savings grow without you adding more money.

What about compound interest?

What it means: You earn interest on your savings and then earn interest on that interest, too.

For example:

  • Year 1:  Save £100, earn £5: Total £105.
  • Year 2: Interest is calculated on £105, not just £100.

Over time, compound interest can significantly increase your savings.

The interest rate tells you how much your savings could grow. Some savings accounts have a variable interest rate. This means the bank or building society can increase or decrease the rate it pays on your savings.

If the interest rate goes up, your savings could grow faster. If the interest rate goes down, your savings will still grow, but more slowly. The bank or building society will usually tell you before they reduce your interest rate.

Some savings accounts have a fixed rate which means you’ll know exactly what interest rate you’ll be getting for a fixed period.

For example, an interest rate of 4% means:

  • £100 could earn about £4 in a year.

  • £1,000 could earn about £40 in a year.

  • £5,000 could earn about £200 in a year.

Looking at actual pound values can often be easier than thinking about percentages.

What it means

You can usually take money out whenever you need it. It can be a good option for people building an emergency fund or saving for something in the near future.

What it means

You agree to leave your money untouched for a set period. In return, the bank or building society normally guarantees the interest rate for that time period.

Question to ask yourself:

Am I happy not using this money for a while?
 

An ISA (Individual Savings Account) is a savings account where any interest you earn is tax-free.

What to be aware of

Be aware that there are restrictions on how much money you can pay into an ISA each year. You can learn more here.

You may see savings accounts advertised with an AER. AER stands for annual equivalent rate. That sounds technical, but all it really provides is a simple way to compare savings accounts.

For example, if one account shows 4.5% AER and another shows 4.0% AER, the first account is likely to earn you more money over a year. 

Inflation means prices rise over time. For savers, the important question is: Is my money growing faster than prices are rising?

For example:
If the interest rate on your savings is 3% but prices rise by 4% (Inflation rate)
Your savings will still be rising, but that money may not buy quite as much as it did before.

Two questions to ask yourself before opening a savings account

1. What am I saving for?

  • An emergency fund needs easy access.
  • Money you won't need for a few years may suit a fixed-rate account.

2. How much could my savings grow?

Ask for examples in pounds and pence, not just percentages. A figure such as "£40 interest on £1,000 over a year" is often easier to understand than "4% interest".

Even if you just save £25 a month, it doesn't sound like much but after a year, you’ll have saved £300, plus any interest earned. 

This UK Savings Week, don't worry about understanding every financial term straight away. Focus on three things:

  • What you're saving for.

  • When you'll need the money.

  • How your savings could grow and support you in the future.

Once you understand those three things, many of the more complicated terms start to make a lot more sense. The best savings account is not necessarily the most complicated one. It's the one you understand and that helps you reach your goal!